“Anyone may so arrange his affairs that his taxes should be as low as possible; he is not bound to choose the pattern which best pays the treasury. Everyone does it, rich and poor alike, and all do right; for nobody owes any public duty to pay more than the law demands; taxes are enforced exactions not voluntary contributions. To demand more in the name of morals is mere cant.”—Judge Learned Hand 1934

When it comes to taxes, you need to have a couple of things firmly in mind. First, your earnings are exactly that…YOURS. It is only after a series of calculations are made and the resulting tax liability (the amount of taxes you owe to the government) is paid that the money becomes the property of the Treasury Department. You are free to arrange your financial life and manage your income in any legal manner that you choose in order to reduce your tax liability to the lowest level possible. Following the provisions in the code that allow you to reduce your tax liability is income tax avoidance and it is perfectly legal. It is not to be confused with income tax evasion, which often involves false statements or tactics designed to hide income that you are required to declare.

Second, any attempt to present the current tax code would go far beyond the scope of this resource. There are simply too many provisions to present all of the ones that might pertain to the average person let alone all of the ones that might pertain to your specific situation. In addition, the code goes through so many changes in the course of a year that even if we were successful in summarizing the current tax code, it would quickly be out of date.

That leaves us with a far more general approach to the subject of taxes and some basic guidelines on the kinds of records that you need to keep in order make the filing of your annual return as painless as possible. Specific strategies will be presented elsewhere in the chapters where they more naturally fit.

Most of us have our own Social Security number memorized. You need to establish a file where all of the social security numbers for all of the people in your family are listed. This is even true of your children. Establish a place in your filing system to maintain your tax records and put everyone’s social security number in that file. It will save you from having to track everything down when tax time rolls around.

When it comes to the documents that you will need to complete your income tax returns with a minimal amount of upheaval, everything usually starts arriving in January. Be ready for that and keep everything together in one place (a drawer, a file, a box) until you are ready to start filling out forms. There is nothing worse than not having what you need when you are trying to beat the deadline.

This will include “W-2’s”, “1099’s” and possibly a whole lot of other things depending on the complexity of your financial life. Income from your job, from your investments (some of which may be tax-exempt, tax-deferred or taxed at a lower rate than regular income), business income, IRA/pension distributions, income from real estate sales, income from rental property, social security benefits, etc., etc., etc. When it comes to income the IRS doesn’t want to miss anything!

What typically comes next are “Adjustments to Income”. At the present time, this includes such things as IRA contributions, interest on student loans, Medical Savings Account Contributions (125 Plans), and self-employed health insurance premiums. For adjustments to income, you will find that the IRS does NOT have a system that captures these items and sends it to you like they do with income. Rather it is up to you to first of all know what adjustments to income are available to you and then make sure that you list everything that you are entitled to. Your filing system needs to include maintaining those records in preparation for filing a return and after you file so that you can substantiate your expenses should you ever be audited.

If you have enough itemized deductions, it makes sense to take them rather than just take the easy way and claim the standard deduction. You usually will not get into any trouble if you claim the standard deduction but you will probably owe less in taxes if you keep the needed records through the year and itemize.

Many people find that a single item is usually enough to justify itemizing: Home mortgage interest. There are limits but for the vast majority of people, interest on a primary residence is fully deductible and usually a high enough figure to make itemizing worth the effort. In addition, you can itemize charitable contributions, job expenses (subject to some limitations), medical and dental expenses (also subject to some limitations), as well as a host of other expenses. Once again, because the IRS tends to lose money as people deduct more and more of what they are allowed, they do not have a really great system in place to make sure that you are claiming everything that you are allowed. They do have a system to insure that you do not claim more than you are allowed but nothing that insures that you have reduced your taxes to the lowest level possible by taking every legal deduction. That is up to you. As with adjustments to income, you need to learn about every deduction that you are entitled do and develop a system that captures that information during the year so that it is available to you when you are ready to file.

In recent years, in an effort to make sure that everyone “pays his or her fair share” (whatever that means), the IRS has been given the alternate minimum tax (AMT). Simply stated it is an alternate way of figuring tax liability. If you have managed to do too good a job in reducing your tax liability, a second calculation (more restrictive in terms of deductions allowed and less generous in terms of income excluded) is made and you may find that even with all of the work that you have done to reduce your taxes to the lowest level possible you still incur a tax liability. At first, the AMT only caught a small percentage of taxpayers but recently there has been an increase in the number of people that find they owe taxes in this way.

There is no substitute for keeping current on your tax situation. If you are interested in doing this yourself then you need to regularly read up on what deductions are available and about some of the ways that you can reduce your tax liability. If this does not interest you, then you need to have a qualified professional not only prepare your taxes, but also advise you on what deductions are available to you and how you go about keeping the documentation that you will need as it comes to you all through the year.

Reducing your tax liability to the lowest possible level through every legal deduction and credit is not only allowed under the law, it is encouraged by the fact that it is the law. Significant dollars can be saved in this way making it possible for you and your family to move towards your goals much faster than would otherwise be possible.

WEB SITES:

www.funwithtaxes.com
www.taxmama.com
www.hrblock.com
www.tdwaterhouse.com
www.irs.gov